More On: Digital dollars
The US military may be the most powerful in the world, but the dollar is its most powerful weapon. After over 80 years of supremacy, the United States may be in danger of losing its place as the world's reserve currency.
Around 60% of the $12.8 trillion in global currency reserves is currently stored in dollars, providing the United States a significant advantage over other nations. And that honor comes with a price: Interest rates are lower because US government debt secured by the dollar is particularly appealing.
The United States can borrow money from foreign countries in its own currency, which means that if the dollar falls in value, so does the debt.
Businesses in the United States can conduct overseas transactions in dollars without incurring conversion fees.
Perhaps most importantly, the US can cut off dollar access to central banks around the world in extreme situations, isolating and depleting their economies. Former Reserve Bank of India governor Raghuram Rajan called this power a "economic weapon of mass destruction."
After Russia invaded Ukraine in February, the US launched this weapon, freezing $630 billion in foreign exchange reserves and severely damaging the ruble's value. As a result, America was able to punish Russia without involving US troops in a conflict.
However, enormous power comes with great responsibility: when you deploy a weapon of mass destruction, even if it's an economic one, people become frightened. Other countries diversify their investments away from the US dollar and into other currencies to avoid the same fate as Russia.
That's where the country's standing as a reserve currency could be jeopardized.
According to Michael Hartnett of Bank of America strategists, weaponizing the currency might lead to its debasement. He went on to say that the "balkanization of global financial systems" is eroding America's role as the reserve currency.
According to a new study by the Foreign Monetary Fund, the dollar's proportion of international reserves has been declining over the past two decades, roughly coinciding with the start of the US war on terror and counter-terror sanctions. Since then, one-quarter of reserves have transferred from the dollar to the Chinese yuan, while the other three quarters have gone into smaller-country currencies.
The paper's co-authors, Serkan Arslanalp of the IMF, Barry Eichengreen of the University of California Berkeley, and Chima Simpson-Bell of the IMF, warned that "these observations provide suggestions of how the international system may evolve going forward."
Russia and China are likewise attempting to influence the international system's future.
On Thursday, Russian President Vladimir Putin threatened to halt gas exports to countries that do not open a Russian bank account and pay in rubles. With no obvious alternatives, the European Union gets around 40% of its gas and 30% of its oil from Russia.
Meanwhile, Saudi Arabia is negotiating with Beijing to accept yuan instead of dollars as payment for Chinese oil supplies.
Is the king dollar on the verge of being dethroned?
Nothing is impossible, if the past two years have taught us anything. However, it is highly improbable that the United States will lose its obscene privilege.
For one thing, the alternatives aren't that appealing. China has been promoting the yuan for years, but the currency accounts for only about 3% of worldwide transactions, compared to 40% for the dollar.
The United States remains appealing to the rest of the world. The US stock market is the world's largest and most liquid, and international cash is pouring into the US. According to the United Nations Conference on Trade and Development, global foreign-direct investment flows increased by 77 percent to an anticipated $1.65 trillion in 2021, whereas investment in the United States increased by 114 percent to $323 billion.
Goodbye, Q1, and welcome, Q2!
The second quarter may not be enjoyable, but at the very least we will be prepared.
The roller-coaster first quarter of 2022 came to a close this week, with major market indices posting their worst results in two years. Inflationary pressures, Russia's invasion of Ukraine, and the Federal Reserve's rate-hiking strategy being accelerated posed a variety of unusual hurdles for investors.
Those difficulties will persist into the second quarter. However, the devil you know is often preferable to the devil you don't.
We asked analysts what they think the biggest headwinds would be in the coming quarter, and how they plan to deal with them. Here's what we discovered.
Markets around the world have been surprised by Russia's invasion of Ukraine. Energy markets, commodities, and even food poverty issues have all been affected by geopolitical turmoil.
To hedge against the Russian conflict, Josh Leonardi, director of prime services at TD Securities, is going to commodities markets, where raw materials are marketed. Wheat is one of his favorite foods. Russia and Ukraine produce around a fifth of the world's wheat. Future agricultural contracts are skyrocketing as supply becomes tight while demand remains constant.
It's probably better not to invest on oil and energy, as these commodities have historically been quite volatile and reactive to news updates.
Inflation: The United States is currently dealing with an inflation problem that it hasn't experienced in 40 years, so it's time to consider real assets as an inflation hedge, according to Leonardi. This entails putting money into commodities, real estate, land, machinery, and natural resources, among other things.
He claims that interest in real estate investment is exploding. "I'm not sure there's anything on the market right now that's hotter. Single-family and multi-family residences, computer centers, and cold storage facilities are all available."
Look for companies that profit from inflationary rises while investing in the stock market. Banks make more money as interest rates rise and spreads widen. Low-capital-requirement companies are likewise a smart bet.
Rate hikes: According to Liz Anne Sonders, managing director and chief investment strategist at Charles Schwab, the Federal Reserve will most likely raise interest rates aggressively in the future.
Investors commonly trust in a safety net known as "The Fed put." It's the idea that if there's enough market volatility, the Fed will stop raising interest rates and tighten policy, or even reverse and ease rates. There's no chance that will happen this time because inflation is so high, according to Sonders.
"Investors should be conscious of this," said Sonders, "particularly if they're being more aggressive because they believe the Fed won't let markets down." They'll keep raising rates in order to slow down the economy. As a result, the likelihood of a recession is greater than it would otherwise be.
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